6:37 PM, February 19, 2014

Detroit wants to divert dedicated property taxes to other services, such as police, fire and blight removal. The city's strategy has rankled Wall Street and could lead to increased borrowing costs for other municipalities, analysts said. / 2012 photo by Romain Blanquart/Detroit Free Press

Detroit Free Press Business Writer

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Judge Steven Rhodes urged Detroit and bondholders Wednesday to negotiate a settlement to resolve their dispute over hundreds of millions of dollars in debt, following a day of arguments in court.

Detroit is not legally required to pay general obligation bondholders in full after filing for Chapter 9 bankruptcy, the city’s attorneys told Rhodes.

But a coalition of bond insurers argued that the city still must pay bondholders because voters approved property taxes for specific infrastructure projects — and not for other purposes.

“The decision here is most likely all or nothing,” Rhodes said. “One side is going to win and the other side is going to lose — and that’s going to be very happy on one side and very tough on the other side.”

Without a settlement, Rhodes said he would issue a written ruling.

“For you to maintain control of this, you’ve got two or three weeks to settle it,” Rhodes said.

Detroit wants to divert dedicated property taxes to other services, such as police, fire and blight removal, arguing that the bonds, taken out over the last decade and totaling more than $300 million, are unsecured debt. The city’s strategy has rankled Wall Street and could lead to increased borrowing costs for other municipalities, analysts said.

Before bankruptcy, bondholders could force the city to raise taxes to pay their debts, Detroit bankruptcy attorney Bruce Bennett said.

“Those people don’t have that right anymore,” he said.

Guy Neal, an attorney for bond insurer National Public Finance Guarantee, said bankruptcy does not allow the city to escape its obligation to pay bondholders.

“These are not simple promises the city made to its bondholders. These are requirements under state law,” he said.

Bennett argued that Detroit’s pledge to use its “full faith and credit” to pay general obligation bondholders was severed when the city filed for Chapter 9 bankruptcy in July.

Attorneys for the bond insurers — which could lose hundreds of millions of dollars if Rhodes allows the bond payments to be reduced — argued they have a lien and property right to the city’s property taxes.

If Rhodes allows the bonds payback to be reduced, Bennett signaled that the city would continue levying the related property taxes.

But he said the city is “acutely aware” that maintaining the taxes could expose the city to taxpayer lawsuits alleging the money is not being used for the purpose specified by voters.

Also Wednesday, the city argued that Rhodes should disband a committee of unsecured creditors appointed by the U.S. Justice Department’s bankruptcy trustee.

Rhodes questioned why Congress would “impose” a committee “that has potentially no value to the bankruptcy process” with all major creditor groups already represented in the case.

He said he would issue a written ruling on that issue at a later date.